In a typical delayed 1031 exchange, you assign to your qualified intermediary (or “QI”) the rights to take your money from the sale of your old relinquished property. This makes many taxpayers feel uneasy. Do you really know what happens to your money while your QI is holding it for you? In this article, we will offer some tips for keeping your money safe and your mind at ease during your 1031 exchange.
The Answer is 100% Transparency
100% transparency means complete openness and clear communication in your 1031 exchange agreement. Your QI should agree in writing that:
- Your money will not be mixed or commingled with any other customers funds or with the operating account of the QI;
- Your money will be deposited directly (immediately after closing of the sale) into a separate segregated FDIC insured bank account; and
- Your exchange agreement will state what rate of interest (if any) will be credited to your exchange account.
More Safeguards - Adding a Qualified Escrow Agent
The treasury regulations say that you can use more than one safe harbor in the same 1031 exchange. Most people just use the qualified intermediary safe harbor in Treasury Regulation 1.1031(k)(1(g)(4).
However, a better, safer arrangement can be set up by requiring your qualified intermediary to deposit your 1031 money directly with a qualified escrow agent. Treasury Regulation 1.1031(k)(1(g)(3) sets out another safe harbor for qualified escrow agents.
Your FDIC insured bank can be the depository AND act as your qualified escrow agent. Even better, you can have a special written escrow agreement that states that two signatures are required to withdraw any money from the bank’s qualified escrow account:
- your qualified intermediary’s signature; and
- your signature.
Your qualified escrow agent cannot be a disqualified person and the written escrow agreement must incorporate the G(6) limitation that you can not have any right to receive, pledge, borrow or otherwise obtain the benefits of the escrowed money during the exchange period.
UCC Security Interest
Another way to add extra security is to perfect a UCC security interest in both the account held by your FDIC insured bank and in the qualified escrow agreement itself. You can do this by filing a UCC-1 financing statement with the secretary of state where your 1031 monies are deposited.
In the unlikely event that your QI fails to perform, you’re not only a creditor, but you’re a secured creditor. If a problem were to occur, it is always much better to be a secured creditor, because secured creditors have first priority to get paid over all other unsecured creditors.
Make sure your FDIC insured bank acting as your qualified escrow agent consents to the security agreement in writing, otherwise you may not get a properly perfected security interest in the qualified escrow account.
Remember, when your exchange is over, you will need to file UCC-3 to terminate your security interest in the deposit account.
- 1031 Hotline: If you have questions about keeping your money safe in a 1031 exchange, feel free to call me at 612-643-1031.
Defer the tax. Maximize your gain.
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